Money Wars: Beating Up On Beijing?

January 23, 2011

Are the U.S. and China on a collision course? Consider the following:

During the 2010 mid-term elections, some 30 candidates for the House and Senate are blasting China for everything from undermining America’s financial structure to fueling the U.S. unemployment crisis.

The Obama Administration is accusing China of manipulating its currency to sabotage the U.S. exports trade, and the U.S. House of Representatives just passed a bill to slap huge tariffs on Chinese goods unless Beijing allows the renminbi, China’s currency, to appreciate.

A recent Financial Times article on the failure of the International Monetary Fund (IMF) to resolve the currency issue says, “The hostility between Washington and Beijing has escalated into something resembling trench warfare.” Last year a CNN poll found that 71 percent of Americans thought China was an economic threat, and 51 percent of those polled thought Beijing represented a military threat as well.

If one adds to the above the growing tensions with China in the South China Sea and the Taiwan Straits, some kind of dust up seems almost inevitable, though any “collision” would be a diplomatic one. But a major diplomatic fallout between the world’s two largest economies has global implications.

What is going on here? Is China indeed manipulating its currency to beggar the U.S.? Does it bear some responsibility for the high jobless rate and the inability of the American economy to recover from the deep recession?

The answer is both yes and no, and thereby hangs a tale.

The U.S. charges that China is deliberately undervaluing its currency, the renminbi, which makes Chinese export goods cheaper than its competitors and thus undermines other countries exports.

China is indeed manipulating its currency, although it is hardly alone. In one way or another, Brazil, Japan, Switzerland, Thailand, South Korea and others have recently acted to keep their currencies competitive. Nor is currency manipulation something new. During the 1980s the Reagan Administration and Japan jimmied their currencies to deal with a huge trade gap. Indeed, the current free market orthodoxy regarding currency is a recent phenomenon in world finances, a reflection of the “Washington Consensus” model that has dominated institutions like the IMF and the World Bank for the last two decades.

How one sees the current dispute depends on where one sits. With U.S. unemployment above 10 percent, Americans are focused on policies that will bring that rate down. But from China’s point of view, any major upward evaluation of the renminbi would simply transfer U.S. jobless rates to China.

Since it would also reduce the value of the dollar, it would lower the value of the massive debt the U.S. owes China. “And that, to the Chinese, would feel suspiciously like a default,” says Stephen King, chief economist for HSBC.

In short, a lose-lose deal for Beijing.

From the Chinese side of the equation, the U.S. is essentially trying to unload the consequences of the economic meltdown that Wall Street caused onto them. And they dispute the fact that the huge trade surplus is all that relevant to the current crisis.

According to Avinash D. Persuad, chair of Intelligence Capital Limited, even if China’s $175 billion trade were to somehow vanish, it would only have a 0.25 percent impact on global GDP. “The Chinese economy is one quarter of the U.S. economy, and at the peak of the U.S. trade deficit, China’s surplus was less than a third of it. David may have toppled Goliath, but he couldn’t carry him,” says Persuad.

Exports have certainly been important to China, but they have only accounted for 10 to 15 percent of growth over the past decade. The main engine for Chinese growth has been investment. According to the World Bank Growth Commission, of the 13 countries that have enjoyed 7 percent growth rates over the past 10 years, all had high investment rates. These countries suppressed consumption by keeping wages low, allowing them to amass enormous pools of capital to pour into upgrading infrastructure or subsidizing industry.

The Chinese economy is booming—it never fell below 8 percent growth during the recession—but it has some vulnerabilities. The Chinese recognize that they need to shift their economy, away from an over reliance on exports to one based more on internal consumption,. To this end, private wages and consumption have been growing at a respectable 8 to 10 percent yearly. The thinking is that as consumption goes up, China will absorb more of its own products, and thus the trade deficit will go down.

China’s new five-year plan is trying to do exactly this. Shifting some of the economy away from the wealthy coastal areas toward the more depressed inland part of the country will help alleviate some of the wealth gap between city and country, and encourage urbanization in the interior. All of these moves will increase consumption.

If China were to suddenly raise the value of its currency, however, it would tank a number of export industries and flood China with unemployment. Since the jobless have no money, consumer spending would fall, setting off yet another round of layoffs and plant closings. This is, of course, exactly what Americans are discovering.

Beijing has begun raising the value of renminbi—it has risen 2.5 percent since June—but the slow pace has not satisfied Washington. The Americans are making other demands as well. For instance, the U.S. would like China to lower its interest rates, which the Americans argue would encourage consumption.

But as Michael Pettis, a professor of finance at Guanghua School in Beijing University and a senior associate at the Carnegie Endowment, points out, “This would be terrible for China. Lower interests rates and more credit will fuel a real estate boom and boost both capital-intensive manufacturing and infrastructure overcapacity—all without rebalancing consumption.”

From China’s point of view the problem is not its currency, but the lack of controls over American finance that can lead to tsunamis of money flooding into underdeveloped countries. In 1997, waves of international investment money poured into Thailand, tanking the currency and spreading a recession, the so-called “Asian Flu,” throughout the region. The Thais took action Oct. 12 to block a similar “hot wave” of money pouring into the country by imposing a 15 percent withholding tax on capital gains and interest payments on government and state-owned company bonds. Besides Thailand and South Korea, other countries in Asia, including Singapore and Taiwan, have also intervened to keep their financial ships on an even keel.

Europeans are blowing hot and cold on currency intervention. Last year and this past winter and spring, the EU had good reasons for remaining quiet about the subject of undervalued currencies. The Euro lost 17 percent of its value vis-à-vis the dollar over the Greek financial crisis, which had the effect of powering up European exports, in particular, by Germany.

Germany—the world’s second biggest exporter after China—is as much concerned about the dollar as the renminbi. “We expect the U.S. to continue its policy of printing money,” Aton Borner, president of the German exporters’ association, BGA, told the Financial Times. “This will trigger a currency devaluation spiral that will hit Europe the most.” The dollar has dropped 20 percent against the Euro since June, and German exports have fallen for two months in a row.

The Europeans are certainly concerned about the currency crisis, although they are a good deal more sotto voice than the Americans. “It’s not helpful to use bellicose statements when it comes to currency or to trade,” says French finance minister Christine Lagarde.

Governments that don’t take care of their own during an economic crisis will eventually pay a price at the polls. Brazilian Foreign Minister Celso Amorim is certainly concerned about defending Brazil’s currency, but he is careful about applying pressure as a way of finding solutions. “We have good coordination with China, and we’ve been talking to them,” he said, adding, “We can’t forget that China is our main customer.”

China charges that the U.S. is scapegoating it for problems that the U.S. created for itself, and there is certainly a strong odor of China bashing these days, even from intelligent and thoughtful people like Paul Krugman, Nobel laureate and New York Times columnist.

Krugman says that while he wants to avoid “hard ball policies,” he says “China is adding materially to the world’s economic problems at a time when those problems are already severe. It is time to take a stand.” Krugman suggests the U.S. should put a 10 percent surcharge on imports from China, a move more likely to ignite a global trade war than bring China to heel.

Last weekend’s meeting of the G20, representing the world’s leading economies, firmly rejected an American proposal aimed at the Chinese (and also the Germans) and opted for a less confrontational approach. The meeting in Seoul, South Korea essentially asked everyone to play nice. Whether they will or not remains to be seen. The subject is sure to come up again in November when G20’s heads of states get together.

The solution is not a quick re-evaluation of the currency, says the Carnegie Endowment’s Pettis, but “statesman-like behavior, in which the major economies agree to resolve their trade balances over several years.”

“Statesman-like behavior” is not exactly what is coming out of Washington these days.